Saturday, March 19, 2005

Baller on wholesale vs. retail muni fiber

In an earlier post I said I hoped to get a few thoughts up about wholesale and retail issues in municipal fiber-optic networks, but 'stuff' (and the installation of a 240 line for a nifty new oven) has gotten in the way. Sometimes, however, life hands you a little present just when you need it. Jim Baller, a leading national telecom lawyer, has recently addressed this issue on the "Getting Illinois Online" list (see LPF's interview with Baller). Not coincidently, LUS is a client of Baller's and his reasoning on this issue may well have influenced Lafayette's decision-making process. Be that as it may, I doubt that there is anyone with more extensive or intimate understanding of the many municipal fiber builds in this country.

[Timeout for some useful background: the text below is a response in a threaded discussion. Such forums—unlike online chat rooms or casual conversation—are places for fairly slow-paced, considered, and fully explained exchanges. We don't have much in the offline world anymore that feels like a good threaded discussion list; the nearest thing I know to this is the older idea of relaying round robin "letters of correspondence," which was the basis for the first systematic exchanges of scientific findings and speculation in the 18th century—a practice the founding fathers appropriated to spread the rationale for the American Revolution. Writers expect that they are speaking to a crowd with a shared history and informed interest in the topic, so the writing tends to be denser than in other contexts.]

The immediate context in which this post appears is an ongoing discussion of whether municipal broadband initiatives (which are assumed to be a good idea) ought to be restricted to wholesale-only models or whether the sale of retail services should also be allowed. One participant on the list, Don, had seen Baller make an argument in favor of "choice" at a conference in Peoria and, knowing Baller was a participant on the list, asked him to repeat the argument for the benefit of the group.

This is the way Baller responded:

OK, Don, here goes.

As I stated at the Peoria conference, my religion is "informed local choice," and I support any feasible involvement model that a community may wish to implement. That includes the wholesale-only model. In fact, several of our clients are currently engaged in wholesale-only projects, primarily because that's all they can do under the laws of their states, and I sincerely hope that these projects succeed. My main objection is to the notion of imposing a wholesale-only model on communities as a matter of legislative fiat, particularly in the absence of hard evidence from the field that a wholesale-only model can actually work over the long term under the conditions present in most municipalities in the US.

Let me give you a simple example that illustrates how a municipal retail model may work in a community in which a wholesale-own model may not. For purposes of this example, I'll focus on video services and ignore most of the other factors that one would typically evaluate in determining the feasibility of a municipal broadband project. I should also note that retail service is not rocket science, at least for municipalities that operate their own utilities. The cable industry's whining to the contrary is just bull-twaddle. More than 100 municipalities have been doing this successfully for years. In fact, Frankfort, Kentucky, has been doing it since the 1950s. An important reason why municipal retail service is relatively easy in the US is that, to stimulate competition in the cable industry, the Cable Act Amendments of 1992 authorized and encouraged the formation of video programming buying cooperatives. Now, virtually every public and private cable operator, except for the giant cable incumbents, gets the vast majority of its programming through a large buying cooperative known as the National Cable Television Cooperative (NCTC).

Now, let's suppose that a municipality wants to build a state-of-the-art fiber system, to give its government agencies, businesses, schools, medical institutions, residents, and others affordable access to symmetrical bandwidth capacity of 100 Mb/s or more. To pay for such a system, the municipality must receive substantial revenues on each major service, including voice, data (including broadband), and video. More specifically for our purposes, in a typical fiber project, financial feasibility will depend heavily on the amount of revenue that the municipality can reasonably expect to receive on video services, either from providing retail service to subscribers, from providing wholesale service to one or more third-party retailers, or from providing a combination of retail and wholesale services.

Next, let's assume that the municipality wishes to push cable rates down as low as possible, effectively giving the community a dividend on its investment in the fiber system and keeping the savings in the local economy, where they will circulate many times over. The municipality, unburdened shareholder demands for high short-term profits, can set retail rates just high enough to recover its costs, including capital costs, NCTC's video programming charges, other operating costs, and amounts sufficient to fund future upgrades. At these rates, the municipal system might well be able to attract enough subscribers to make the project feasible. (One would determine this through surveys, focus groups, interviews, experiences in other projects, etc.) If the municipality set its rates much higher, it may or may not be able to overcome the existing cable operator's advantages of incumbency -- i.e, an existem system built and largely paid for with monopoly profits, earned before there was any competition, a starting position of dominance in the market, ongoing revenues from a substantial subscriber base, subscriber inertia, the ability to use its cable system to flood subscribers with disparaging statements or disinformation about the municipal system, and a host of other advantages.

Finally, let's assume that the municipality is limited by state law to providing wholesale service and can proceed only by injecting a private-sector retailer into the mix. The retailer will have to set rates high enough to cover the municipality's wholesale rates (through which the municipality must pay for the fiber system), NCTC's video programming charges, the retailer's other capital and operating costs, and a sizable markup to generate the profits that the retailer's shareholders demand. Especially in small markets, in which there are relatively few potential customers to spread the costs of a fiber system, this may push rates high enough to leave subscribers little incentive to switch away from the incumbent. Furthermore, many subscribers may view the private-sector retailer as just another profit-driven outsider that will siphon revenues out of the local economy. In these circumstances, lower anticipated take rates might well render the project financially infeasible, as well as much less attractive to the community.

With regard to Jeff Sterling's suggestion that the Nordic countries are proving that "open access" works, that is not inconsistent with my point that we have "no long-term evidence from the field demonstrating that wholesale-only actually does work." For one thing, "open access" and wholesale-only are not the same thing. A municipality can offer "open access" to its system and at the same time provide one or more retail services. In fact, most municipal fiber systems are doing this, and the FCC has found that concerns about potential bias can easily be addressed by non-discrimination and competitive-neutrality requirements. Furthermore, I wish Europe's experiences translated well here, but I don't believe that they do. When I was recently in Amsterdam to speak at the European FTTH Conference, I listened very carefully to the European presenters and talked at length with many of them about their projects. In particular, I had several long talks with the founder and initial head of Skokab. I'm afraid that I just don't see Skokab or any of the other other European model working in America, at least as long as we require our systems to be fully self-supporting and our incumbents are intransigent about working cooperatively with municipalities.

In the end, even if the evidence showed that the wholesale-only model does indeed work -- which simply cannot be true in all situations -- I still wouldn't force it upon communities. Undoubtedly, many communities would choose the wholesale-only model, particularly if they lacked the experience to provide retail services themselves, but others would not. I strongly believe that communities are the best judges of what's best for them and should be free to decide these matters for themselves.
Jim Baller
Baller is speaking in a discussion among friends of municipal broadband. In another context, the most powerful argument might be very simple: if you want to know what the most powerful and secure business model for this sort of enterprise is, look around and find out which model the most successful participants in the market use. In our context--ask what BellSouth and Cox do. What you will find, of course, is that BellSouth and Cox would laugh you out of the house if you suggested that they'd be better off deciding to go to a wholesale model and let other companies take a share of the profits made possible off their investment in their networks—companies without the gumption to build the necessary infrastructure for themselves. In fact, they don't allow anyone on their networks unless the FCC demands it. LUS should be allowed to adopt the same powerful business models that its competitors use.

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